While trading cryptocurrency, you’ve probably observed that trade orders don’t consistently execute at the precise price you want. Sometimes the order will run at a higher price, and others will perform at a lower price. This is referred to as price slippage.
Several cryptocurrencies need more liquidity, making avoiding slippage while trading them difficult. Also, if you are a short-term or day trader, it may be tough to sell using limit orders every time.
So what causes slippage, and how can you prevent it?
What Exactly Is Slippage?
Traders often trade with predetermined pricing in mind. You will only open a chart setup and trade with an aim. Whether purchasing or selling a cryptocurrency, you want to do it at a specific price.
When slippage happens, you will be forced to accept a price different than you requested. The circumstance is frequently triggered by a price change between when the order is placed and when it is executed.
Slippages may be beneficial or detrimental depending on how they affect your deals. Positive slippage gives you an advantage in the market since your order is executed at a lower price than the one you placed initially. For example, if you complete a purchase order that executes at a lower price than you requested, you are in a stronger position, allowing you to get a higher purchasing rate and earn more money.
Positive slippage is the inverse of negative slippage — the pricing adjustment results in a lower price for your product than you originally bought. For example, suppose you attempt to sell one LTC for $50, but the order is completed at $48. Your deal was performed at a lower price in this situation.
What Causes Slippage in Crypto Trading?
Slippages in the crypto market are caused mainly by price volatility and a lack of liquidity.
- High price turbulence
Volatile asset values distinguish the crypto market. Because of the market’s volatility, orders are prone to slippage. Moreover, variables, including demand and supply, market mood, user enthusiasm, and government restrictions, all impact the price of cryptocurrencies. Since the market is new, these considerations have an enormous impact.
- Low market liquidity
Since specific cryptocurrencies are not widely used, they have low liquidity, rendering them vulnerable to slippages. There are few buyers and sellers when a token has limited liquidity. Thus, if you make an order, particularly a big one, the price may vary when the system fulfills the order, shifting the cost from your execution.
The less liquid a market is, the less likely substantial price slippage. Assume you wish to purchase one unit of a crypto asset for $200. When you enter a transaction, it is executed at the best price in the order book. The order cannot be filled if the current best order contains just 0.5 units of that item. The algorithm then explores the next level to see whether the order can be extended. The possible execution price rises as the price to fulfill the order increases. This implies you’ll have to pay a higher price to satisfy the order. The optimal market price in this scenario is a lower rate.
What Exactly Is Slippage Tolerance?
Setting a slippage tolerance percentage allows you to manage your exposure to slippage. Setting your slippage tolerance to a portion implies you are okay with the price fluctuating by that percentage, either upward or downward.
For example, if you set your slippage tolerance to 3% and wish to purchase $100 worth of a crypto asset, you are okay with the deal commencing at either $103 as the highest or $97 as the lowest price. The exchange will not complete the contract if the price falls below $104 or $96 per share.
With a high slippage tolerance level, your transactions will be executed despite price changes. High slippage tolerance is often utilized when trading in a turbulent market or investing in crypto projects with little liquidity and high transaction volume, such as a coin launch project.
Yet, high slippage tolerance percentages might expose you to front-running. Front-running is the unlawful practice of using information to acquire and sell securities ahead of time. When the attacker notices a pending transaction, they put a considerably bigger transaction before and after it. This method encourages you to pay the most excellent possible slippage price depending on your settings while the front-runner gains from the value differential.
Ways to Prevent Slippages
Slippages may be costly, mainly if you are a short-term trader who makes several deals. There are, however, techniques to minimize or at least decrease the impact of slippages in your transactions, which we shall discuss below.
Limit orders are one technique to prevent slippages while trading. Slippages may only occur when market orders are used. Market orders are trade orders that execute at the best market price. Limit orders ensure that your order is completed at the precise cost you want rather than at a lower price, as with market orders.
Setting limit orders has a significant disadvantage in that they are not guaranteed to execute; as a result, you may lose out on a chance to initiate a desired transaction.
Trading in less volatile markets is another approach to lessen the impact of slippages on your transactions. Given the cryptocurrency market’s usual volatility and rapid price swings, this may seem unachievable. To minimize massive slippages, you should avoid trading at times when significant events or announcements may impact the market. During such times, prices are prone to extreme volatility.
Investing in highly liquid assets will help lessen the impact of slippages in your transactions.
Market orders are prone to slippages, although if the price discrepancies are minor, the slippages may be insignificant. If your approach necessitates quick trade execution, you may see price discrepancies as a variable cost of carrying out transactions that should be kept as low as possible.
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